The COVID-19 pandemic has triggered a transformation into a “new economy.”
“The economy was a very nice photo, than the pandemic turned it into a jigsaws puzzle that’s all messed up, now we’re trying to put it together and figure out if all the pieces are still here or not.”
Mohammed A. El-Arian, Chief Economist, Allianz
The novel COVID-19 virus has driven the world economy into the deepest recession since the Great Depression and shattered the linkages that held it together. Economists are still trying to make sense of what has happened to the supply chain and demand channels. As El-Arian, notes key economic components may be missing. As such, some new components will need to be created. All these components will then need to realign into a “New Economy.”
The challenge of rebuilding the economy will be influencing consumer behavior. Consumer spending is 70% of GDP. Thus, growing employment is crucial toward increasing consumer confidence and recovery. The central question is: how will the economy shift to a growth track? We’ll look at crucial signposts along the way in building a new growth track by presenting the following topics: (Note: This article, Part 1, includes sections 1, 2, 3 below. Sections 4 and 5, which look at the “new economy” will be forthcoming in Part 2.)
- COVID-19 – Unique Event – Examines the unique characteristics of the pandemic and how they set up specific economic trends. Part 1
- Virus Drives the Economy – Looks at how the virus is driving the economy, how it is out of control and what strategies are working toward containment – Part 1
- Outlook For The U.S. Economy – Takes a new perspective by overlaying the virus cycle with a deep “U shaped” economic cycle and how economic activity changes during each stage of the cycle. – Part 1
- New Economy – Describes the transformation of our society, how these changes will create winning and losing businesses, and how consumers will likely have more conservative spending and saving habits – Part 2
- What We Need To Do To Create a New Economy – Recommends a federal team of scientific experts be authorized to lead virus containment, investment in self-renewing innovation centers in hard hit pandemic areas, and focus employment development on climate change solutions – Part 2
COVID-19 Unique Event
The COVID-19 crisis is causing deep psychological shock combining panic, depression, and recession. It is a new type of crisis or ‘panipression’. We combined three-word stems: pan for all and Greek word for their god of terror in the word panic, press a state of pressing down and sion for state or quality of something.
People are emotionally stressed, not sleeping well, and worried about their families as in other recessions. Unlike other economic speed bumps, health is added to their worries. It is a sense of falling, that doesn’t seem to stop. This worldwide virus contagion is incredibly pervasive, going right to the heart, soul, and experience of every American. The social fabric of our society is being shredded.
Now we must stitch our social fabric back together. Every day our way of living is turned upside down. The previous ways of doing things have disappeared; social interaction has shifted to digital networks. It has been a fast two-month social upheaval, and we are in just in the early stages of the transformation.
Business leaders are grappling with this tsunami of change and what it will mean to their businesses. Executives used the word ‘unprecedented’ 50% more in their recent first-quarter earnings conference calls than in the descriptions of business conditions during the Great Recession.
Virus Drives the Economy
Since March 11th when a national emergency was declared, the COVID-19 virus swept swiftly through the country to cause 84,100 deaths and 1.3M infections at an average rate of 22,000 per day.
Source: New York Times – 5/14/20
The economic impact has devastated U. S. economy, with 36.5 million people receiving unemployment assistance, an unemployment rate of 14.7% in April, and 30% of Americans reporting a drop in income.
When the virus infection and death rates drop steeply for an extended period, then the economy will begin to recover. So, how are policymakers succeeding in controlling the virus? Dr. Anthony Fauci, White House Infectious Disease Advisor, testified to the Senate on May 12th that the virus is still out of control. He expected by now to see a steep drop in the new infection rate but instead sees a slow decline with peaks. The performance of states in mitigating the pandemic impact is due to several factors such as how early lockdowns were instituted, population density, and hospital infrastructure. Performance rates vary widely from California’s death rate at 7.5 per 100k, to 140 for New York.
What techniques are working to rein in the virus? The New York Federal Reserve examined the 1918 Spanish Flu pandemic and found that early lockdowns and social distancing had a positive impact on mortality rates and medium-term employment growth.
Sources: The New York Federal Reserve, New York Times – 5/5/20
Researchers noted that very different results occur in the same geographic area, such as the twin cities of Minneapolis and St. Paul. Minneapolis had a longer lockdown period and a 30% increase in medium-term employment versus St. Paul that had a shorter lockdown period and only a 15% employment increase.
States like California instituted early lockdowns and are very slowly phasing in the economic opening. Other states like North Dakota did not implement lockdowns, while others varied significantly in how quickly they instituted lockdowns. States were left on their own with only vague national guidelines on what levels of virus control they needed to achieve to reopen their economies.
The following two charts show the status of lockdowns organized by state and infection rates in nine key states. Of significant concern are states that are opening up which have increasing infection rates: Mississippi, Tennessee, Georgia, North Dakota, Utah, Alabama, Missouri, Texas, and South Carolina:
Sources: Bloomberg, COVID Tracking Project – 5/6/20 & 5/7/20
A Yale School of Public Health analysis showed that travelers from New York in March and April seeded an average of 82% of the infections in the Mountain West, Midwest, South, and East and 43% on the West Coast. Thus, cross-infection from virus hotspots spread and continue to spread throughout the U.S. to areas where the virus was thought to be controlled.
Dr. Fauci warned in his Senate testimony, that opening states too early without widespread testing, tracing, and treatment infrastructure in place increases the probability of a second wave of infections and threatens economic recovery. Most states only test people if they are symptomatic, so we don’t know how widespread the virus is in our communities. Some states are just beginning to gear up comprehensive tracing programs. Treatment drugs like remdesivir show promising results in speeding the recovery of infected patients, but has limited distribution. The point is the virus is ahead of U.S. containment efforts, Dr. Tom Frieden, former director of the Centers for Diseases Control and Prevention observed:
“We’re not reopening based on science, we’re reopening based on politics, ideology and public pressure. And I think it’s going to end badly.”
Outlook For The U.S. Economy
The virus is driving the economy right now, so overlaying the phases of virus infection and containment with a U shaped economic cycle is helpful to understand the direction of the economy. The Federal Reserve and federal government have focused on providing ample liquidity to the economy and temporary relief to consumers. But, the path to build consumer spending is unclear. We have decided to focus on consumers by reviewing how during each phase of the economic cycle key factors change, such as unemployment, small business, job loss expectations, and consumer confidence. World trade was added to understand how American companies may benefit from increasing trade to boost the economy and employment. Shifts in these indicators act as signposts along the path toward recovery.
Source: Patrick Hill – 5/12/20
Contraction Phase –The economy seems to be in the early stages of a contraction based on the huge jump in the unemployment index for April of 14.7% reported by the Bureau of Labor Statistics. Neil Kashkari, Federal Reserve Governor for Minneapolis, noted that if those misclassified unemployed are added the unemployment rate, it is closer to 20% or 1930s levels. Plus, if a person stops looking for work they are then viewed as out of the labor force and not counted. Due to ‘panipression’ many workers will be stunned and have a difficult time even start a job search. The economy will not come out of the contraction phase until the virus is contained, or at least it becomes evident to consumers that it is safe to go out into the community to shop, travel, or work.
Large corporations accessed their credit lines by $200 billion in April. Plus, large businesses have had good access to bond markets and private equity that small companies don’t enjoy. The Small Business Administration estimates that there are 31 million small businesses in the U.S., with fewer than 500 employees. Small businesses are the hiring engine of the economy with 64% of all U.S. new hires in 2019, creating 1.5 million new jobs. The majority of small businesses have only twenty-seven days of cash, and then they must have to borrow heavily or close their business. Only 30% of small businesses are making a profit, with another 30% breaking even and 40% losing money. Thus, 70 % of small businesses were already on a financial cliff as lockdowns began in mid-March. Forty percent of all small companies missed their May rent payments.
Sources: The Wall Street Journal, The Daily Shot – 5/4/20
Congress quickly funded the first phase of the Paycheck Protection Program (PPP) in early April with most of the funds going to existing large bank customers and many major corporations, leaving millions of small businesses off the list. A significant benefit of the PPP program was the conversion of the loan to a grant if funds were used primarily for keeping employees on payroll until July 30th. Subsequently, Congress passed a second law providing an additional $484 billion for PPP funding. Banks began taking applications on April 30th. Audits show that of those small businesses applying for funds, 70% were approved, and 60% had received checks by May 11th. So, many small businesses now have funding. However, the funding law was general in establishing the use of funds requirements and left the final spending rules to the Treasury department.
The Treasury department set rules placing a 25% of total loan value limit on rent, mortgage, and utility payments. Even with the PPP assistance, many small businesses in major cities with high rents like New York, San Francisco, Los Angeles, and Chicago will be hard-pressed to pay fixed costs like rent and utilities.
A survey by the Society for Human Resource Management (SHRM) of small businesses reported that 52% of owners expected to close within 6 months, or about 15 million firms. The SHRM survey was conducted before the second wave of small business PPP loans. It is possible that many businesses that were denied the first phase of PPP funding will receive funding during the second wave. Another program of loans by the Federal Reserve for small businesses will likely not help many small businesses as the Fed tightened eligibility requirements.
All these relief programs need to be inclusive, flexible, and fast, or there will be a small business solvency crisis this summer. We are concerned about all the chaos and confusion, so we forecast a reduction in the number of small businesses to 22 million by the end of the contraction.
A Bankrate job security survey showed that 25% of workers said they expected to lose their job within 12 months. Their insecure job expectations fit with the loss of consumer confidence for April, the steepest drop in five years. The direct payments of $1200 to individuals will help to provide temporary relief through July, but after that month, it is not clear what many workers will do if their temporary furloughs turn into permanent job layoffs.
Economists forecast a conversion of temporary to permanent layoffs to range from 10% to 45%. For example, airlines have been hit hard with planes only 10% full for April. If passenger traffic does not bounce back quickly in the summer, permanent layoffs are likely to rise in the fall. High tech companies that depend on advertising like Google and Facebook will not be immune to the decline in consumer spending. A 33% drop in ad spending is forecast for this fall. Thus, there may be layoffs in the high technology sector as well. As layoffs continue, the number of workers expecting to lose their job in 12 months may increase to 35%.
World trade will not lift the U.S. economy out of a recession. The World Trade Organization forecasts a reduction of year over year of world trade by 10% with a decline to – 25% by year end. S & P 100 corporations receive 60% of their revenue and 70% of their profits from overseas customers. A decline in foreign business will squeeze profit margins as well. The U.S. and China are exacerbating the trade tension with threats related to the pandemic and the Phase One trade deal. U.S. businesses will come under increasing federal government pressure to move manufacturing back home for strategic reasons causing an increase in payroll and overhead costs. Reducing costs and market access are vital reasons why firms moved offshore to begin with, and now those advantages may be lost.
Trough Phase – As the virus comes under control, we expect the economic damage will last longer than the health impact on people. During this phase, the next level of economic activity will begin as the economy stabilizes at a much lower level of activity. Optimistic forecasts call for consumers to jump right back into their pre-pandemic buying habits, yet surveys of consumer buying interests show their reluctance to leave home. The New York Times reported in a survey that showed even in states that opened quickly, consumers still did not want to leave home for shopping, sporting events, or travel. A survey of 6,730 adults from lockdown and opening states confirmed consumer hesitation:
Sources: The Democracy Fund, UCLA Nationscape Project, New York Times – 5/8/20
Unemployment will stabilize at 24 %, as federal government programs to jump start public works projects assist but are not likely to stem the tide as the government does not have the funding or political will for major projects.
The number of small businesses will slip to 18 million in the early stage of the trough. Small businesses will have a tough time surviving the control of major companies moving into their market segments and buying up failing businesses to gain market share.
We expect consumer confidence to drop to a twelve-year low at 25, as job prospects dim. Companies will be in survival mode and reluctant to hire. Management will be looking for signs of steadily increasing sales and a stabilizing economy. We forecast that as the economy stabilizes, consumer confidence will rise to 55.
Workers that have jobs in information technology and software services will likely be the first group to increase consumer purchasing and resume major purchases for cars and trips.
Millennials and those low on cash will further shift to using car-sharing services. Automotive companies will likely see declining sales overall.
Corporations will find that they need workers in customer-facing positions or want to differentiate their services with personal assistance.
Manufacturers will install automation systems next to workers to drive production output up while meeting social distancing requirements. Automation systems will stay in place.
During this trough phase, it is likely that those left out of the previous expansion will be frustrated and look for more government programs and support that will put even more pressure on the federal deficit and the Federal Reserve to monetize the debt. The federal government will be hard-pressed to provide fiscal stimulus to the economy, leaving the private sector to lead investment in growth sectors. The economy will show peaks and valleys in different industries, but overall the combined growth will likely be flat and cap business revenue growth year over year.
Trade will stay depressed as the U.S – China trade war splits world trade into two blocks with bridge-building countries like Australia and Singapore providing conduits of international commerce. World trade hits a low of -32%. Please see our post Navigating A Two Block Trade World for further analysis of the shift in world trade patterns. Finally, the entrepreneurship engine that typifies the U.S. self-renewing economy will begin to show ‘green shoots’ from startups giving hope for recovery just around the corner.
Recovery Phase – Consumers will feel comfortable freely moving about and quit thinking about the possibility of becoming infected.
Unemployment will fall to 12.7% as creative small businesses during the contraction, and trough phases begin to gain traction deploying their business models. Private equity firms and banks will be more willing to finance expansion as they see business revenues increase and profits start to emerge. New high tech and software services startups incubated during the trough phase will start growing quickly and hire new workers at an accelerated rate.
New small businesses will develop in various business segments, including online services, personal assistance, home-based applications, and health advice. Artificial intelligence is no longer isolated as a field but is integrated into autonomous cars and trucks, healthcare, and personal services. More details on the winning and losing businesses and new sectors of the New Economy please read Part 2 of this article.
The number of small businesses will increase to 22M and begin to lift the economy and communities. Worker job expectations that they will lose their job in 12 months falls to 14% and a more moderate 9% by the peak in the recovery period.
Consumer confidence will solidly increase, causing spending to grow and drive business revenues and earnings into the black as economic momentum takes hold.
Trade will finally increase by plus 5% as countries tired of combating each other find they need to collaborate to rebuild the global economy.
We expect corporate leaders to take the lead in employment development for a long term economic transformation as political divisions will continue. We noted in our post: A Pandemic Iceberg Hits the ‘Unsinkable’ US Economy’ that the fabric of a solid labor safety net needs to be built to mitigate the impact of an economic crisis like COVID-19 on labor in the future. It is in the interest of executives to build businesses where workers are thriving, not just surviving. The focus must be on building an innovative economy that is creating new jobs through entrepreneurship. Otherwise, we are faced with a stagnating economy dependent on government transfer payments. We conclude with the following declaration from that post:
“Americans built the most innovative, self-renewing, wealth building economy in the world. It is the American spirit of entrepreneurship combined with invention, self-sacrifice, equal opportunity, and creativity that will build the businesses of the future. These new businesses will adjust to new social realities and pave the way for workers to gain job security and become confident enough to spend at robust levels.”
Patrick Hill is the Editor of The Progressive Ensign, https://theprogressiveensign.com/ writes from the heart of Silicon Valley, leveraging 20 years of experience as an executive at firms like HP, Genentech, Verigy, Informatica, and Okta to provide investment and economic insights. Twitter: @PatrickHill167